The second in a series of special reports

Special Report

Smart Growth: Innovating

to Meet the Needs of the
Market without Feeding
the Beast of Complexity

www.georgegroup.com http://knowledge.wharton.upenn.edu

C ontents
S mart Growth: Innovating to Meet the Needs of the
Market without Feeding the Beast of Complexity
As companies struggle to innovate in todays competitive environment, they need to
continually guard against adding to their clutter the creeping impact of complexity
on efficiency and cost-competitiveness. In this three-part special report, experts from
Wharton and George Group Consulting discuss how management can approach this problem by thinking ambidextrously that is, focusing on innovation and broad exploration
while minimizing the impact of clutter on operational processes and costs. Also, Mike
McCallister, CEO of Humana, discusses balancing innovation and complexity in the health
care industry with Wharton management professor Michael Useem and Stephen Wilson,
engagement director in George Groups Conquering Complexity practice.

Part I: Innovation vs. Proliferation: 

Getting to the Heart of the Customer

Page 1

How can companies innovate without falling into the trap of needless proliferation in their products or services? The
key, according to Wharton faculty and experts from George Group Consulting, is understanding unmet and unarticulated consumer needs while aligning innovation processes to those insights.

Part II: The Impact of Clutter on Time-to-Market

Page 6

It seems all too obvious that companies shouldnt spread their innovation resources too thin. Experts from George
Group Consulting and Wharton note that firms investing in product and service innovation, but not process innovation,
can miss out on capturing the initial gains of market share.

Part III: Getting a Grip on the Costs of Complexity

Page 9

Determining the financial impacts of innovation-related complexity begins with taking a close look at existing
operations to understand the actual cost incurred and value generated at each step in the process all the way
from idea generation through product development, manufacturing, marketing and customer support, among other
back-office functions.

Humana CEO Mike McCallister: 

Letting the Consumer Drive Innovation

Page 11

Mike McCallister, CEO of Humana, one of the United States largest publicly traded health benefits providers, is leading the companys change from a traditional one-size-fits-all health care delivery model to one in which product
innovation is driven by consumer needs. McCallister spoke with Wharton management professor Michael Useem and
Stephen Wilson, engagement director in George Group Consultings Conquering Complexity practice, about managing
complexity while innovating in a rapidly changing industry.

I. Innovation vs. Proliferation: Getting to the Heart of the Customer

What is the next big idea or market
opportunity? The question plagues CEOs of all
growth-hungry companies as they race to scoop
their competition with a product or service that no
one has thought of before. But how do companies
know what products and services their customers
want and will be willing to pay for next?
Henry Ford famously said, If I had asked my customers what they wanted, theyd have asked for a
faster horse. In other words, the road to true innovation is rarely illuminated by customers telling you
what to do next; they may often not know what they
want next. But, experts from Wharton and Dallasbased George Group Consulting warn, unbridled
proliferation in the hopes of hitting it right can
lead companies into the trap of having too much
complexity, which consumes existing resources and
ultimately harms returns. It is a difficult tension to
manage and one which requires a level of ambidextrous thinking. The key, they say, is for companies to identify the unmet and unarticulated needs
of the customer and align their innovation processes to those insights. Companies must discover what
innovations customers are willing to pay a premium
for, identify their own competitive strengths and
free up innovation capacity by removing or managing complexity within the organizations products,
services and operations. The potential reward is
a better bottom line and increased visibility with
customers, as companies invest in understanding
customers needs while shedding the excess clutter
that can bring down their rivals.
Fords words resonate even today with Dan Chow,
senior vice president at George Group and leader of
its Fast Innovation practice. As an example, he says
there was no sure-fire way to know that customers needed an iPod, Apples MP3 player that has
taken the market by storm. While you might not be
able to come up with the specific thing called iPod,

you can reliably generate iPod-like ideas by using

different and varied sources of innovation fuel,
says Chow. Challenging conventional wisdom and
understanding core capabilities tend to be the fuel
that helps companies generate out-of-the-box thinking to push them to new ways of uncovering customer needs.

Unbridled proliferation in the

hopes of hitting it right can lead
companies into the trap of having too
much complexity, which consumes
existing resources and ultimately
harms returns.
For example, says Chow, the real innovation with
the iPod is its business model tying music to
great user design to great brand cachet. And behind
that success is the fact that deeply understanding
the customer is the first and most important capability a company can have to drive innovation, he says.
To illustrate that idea, Chow points to the example
of a school supplies company that was challenged
with commoditization of their product in the office
and discount channel. Their product was purchased
most heavily in the back-to-school season by students. Looking beyond the features and functions
of the product in the hands of the student, to the
frustrations, delights, wishes and concerns of students and their parents, led to an insight: There was
an opportunity for the company to differentiate itself
by addressing the broader needs of parents during
what was an anxiety-ridden time of year. Armed
with this idea, the company started selling complete
solutions integrated packages of school supplies

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

 so that parents could do away with their lists and

a bit of their anxiety. It also gave the parents more
time a precious resource for which they would
happily pay a premium.

market for half-the-calories beverages. The problem was that there was no market, says Reibstein.
Pepsi went chasing Coke into a dead end and
ended up wasting millions of dollars.

It is only through identifying these unmet needs

that companies can continue to secure premiums in
the market, Chow says, adding that this approach
contrasts strongly with what is often a knee-jerk
response to higher levels of commoditization:
increased proliferation of features, attributes and
product variants.

Reibstein says companies often launch new offerings because they are afraid theyll miss the boat.
He recalls how a few years ago there was heightened speculation about the emergence of a paperless society, where credit cards would replace cash
and so forth. He also talks of similar expectations
in recent years of video-on-demand technology
replacing video stores. Markets are much slower to
change than people would ever imagine, he says.

Distinguishing Innovation from Product

Proliferation
But discovering what customers need isnt always
easy, and this is exacerbated by the fact that many
companies often go down the wrong innovation
path due to internal biases. Kevin Werbach, Wharton
professor of legal studies and business ethics, says
that Apples innovation strategy is distinguishing itself from conventional MP3 players by being
scored in simplicity and resisting the influence
of internal biases. Too often, consumer technology
product makers tend to over-feature their innovations. These are geeks who want to add the latest
new thing and historically have a tendency to make
their products too complex, he says. They are
technology experts, and their tendency is to build
the product they can use, which is not the mainstream product.
Werbach says iPod is a big counterexample of
that trend. They didnt try to put in every feature;
they stripped it down and focused on a really great
design and user interface, even though it by no
means was the first portable digital music player.
A simple and functional design similarly helped
Google, says Werbach. There were plenty of search
engines before Google, but sites like Yahoo! and
others got so clogged up with features that tried
to get people to buy ads and buy other services,
he says. Google, he notes, stuck to a simple search
offering. Users loved the plain screen with just a
couple of links. Eventually, it paid off handsomely,
notes Werbach: As it turned out, Google figured out
a way to do it and still become more profitable than
all those other [rival] companies.
In some senses, Google had a me-too offering,
but it clearly did not replicate its predecessors.
David Reibstein, professor of marketing at Wharton,
says unforeseen perils await those who blindly
follow their competitors. He recalls how PepsiCo
followed Coca-Cola into the seemingly promising

George Group | Knowledge@Wharton

Experts at George Group note that without a strong

understanding of what value new products are providing, it is very easy for companies to drift off track;
they may be simply going through the motions in
their innovation practices. A key question, they say,
is: Are you innovating, or are you simply creating
more SKUs (stock-keeping units)?
Much complexity seen or unseen is the result
of going too far with what companies misread as
innovation, says Matt Reilly, a senior vice president
at George Group. Some [corporate] leaders mistakenly confuse innovation with product proliferation,
he says. The problem, he explains, is when companies dont really understand what their customers
perceive as value and what they are willing to pay
for. Companies wind up over-featuring and overdeveloping to the extent that they become focused
only on building something new, not necessarily
building something profitable or building something
valuable. That gets further complicated, he says,
when companies dont get a grip on how well they
can actually execute that [innovation].
Reilly notes that, unlike three to four years ago, the
stock markets dont value revenue growth alone;
they now reward profitable growth. Yet, a lot of
these product companies are focused on driving
top-line growth; the cost and the complexity of actually executing all these new offerings is typically not
factored in, he says. That situation persists in many
companies, he adds, because marketing people are
often dangerously disconnected from operations
and are rewarded for remaining that way.

Finding the Heart of the Customer

How can companies begin identifying customers
unmet needs, and particularly those they are willing
to pay for?
According to the book Fast Innovation: Achieving
Superior Differentiation, Speed to Market, and

Increased Profitability, by George Groups Michael

L. George, James Works and Kimberly WatsonHemphill (McGraw-Hill, 2005), sources for analyzing customers needs might include ethnographic
studies; face-to-face interviews with end-users and
customers; diaries and intercepts; and expert advice
and trend analysis on technology and markets. These
help companies measure, explore and make tradeoffs among customer requirements, the authors
write. Where differentiation in offerings is calibrated
carefully to customer needs and fast-tracked to market, there is larger-than-usual opportunity to realize
premium prices before commoditization.
What the authors found was that many companies
spend too long in development time, and too little
time and money in the upfront stage, leading to
an inadequate understanding of customer needs.
Companies are then compelled to commit more
investments post-launch as they begin to understand customer responses and tweak their offerings.
Jason Santamaria, engagement director in George
Groups Fast Innovation practice, recalls an initiative
to uncover customers underlying needs in a recent
consulting assignment. The firm in question was a
$400 million telecommunications equipment company that faced inadequacies in its own understanding of a particular customers needs. The customer
a telecommunications service provider was
equally lost about what it wanted.
But Santamarias client had one advantage: It possessed the expertise to deal with the highly technical and complex nature of its products, a capability that the customer lacked. One of the A-ha!
moments was helping the [client] company realize
that one, the customer was uncertain of its [own]
needs, and two, it needed to work with the customer in a collaborative fashion to uncover those
needs, says Santamaria. The first step was to bring
his clients engineering managers into direct contact with the customer so there was no filtering of
information between them. The telecom equipment
maker and its customer adopted a rapid prototyping process in which the customer was presented
with iterative prototypes of the product during
development. In this case, it was a telecommunications traffic analysis tool.
According to Santamaria, Instead of the traditional waterfall approach where you receive a set
of requirements from the customer and you go
out and develop it and present the final product to
the customer, we adopted a spiral design method
where the engineering manager was in regular contact with the customer, and we repeatedly placed

prototypes in front of the customer and got that

customers feedback. The end result, he says, was a
final product delivered in a dramatically more accurate manner than the waterfall approach would have
yielded. The takeaway, he notes, is that the key to
customer insight development is to look across the
entire value chain for insights, and not rely on your
channel partners to do the consumer work for you.

Giving Customers the Faster Horse

Without a broader view, innovation efforts may
be reduced to simply reacting to every little
request from customers. In fact, argues George
Groups Stephen Wilson, co-author of Conquering
Complexity in your Business, many companies are
still responding to customers requests for a faster
horse to borrow the Ford analogy without
a view to the impact on the companys costs and
processes, nor to the long-term strategy of the company. Complexity creeps in, and these companies
wake up to a sprawling portfolio with burgeoning
costs and unintentionally find themselves unable to
serve customers well.
One company, operating in a fairly mature market,
had built a strategy of having the broadest possible offerings and being very responsive to the
customer, he says. But they were not necessarily
being innovative. The company was engineeringfocused and tended to respond to every customer
request for a product variation, Wilson notes. They
were so busy doing the incremental changes that
they had no time to really innovate. Over time, it
absorbed their capacity to innovate. That also left
the company vulnerable to competition, which
scored better on speed to market and customer
service. By trying to respond to every customers
specific requirements, they lost out on addressing
customers more basic, fundamental needs.
Moreover, he adds, the company was not able to
generate premium margins sufficient to cover the
incremental costs of complexity. Decisions based
on incremental revenue were driving massive
amounts of waste in the organization, he says.
Inventories ran into millions and millions of parts.
In such a situation, Wilson recommends getting a
clear perspective on what is really important to the
customer and what they will pay premium prices
for. Internally, management needs to adjust its focus
from chasing market share to value share, which
means getting an increasing share of the margins
available in that market segment.

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

When it comes to matching customer needs with

what could justify premium pricing power, Reilly
points to a big disconnect that many companies
fail to see: They often have detailed data on size of
the market, pricing and trends, but dont often have
good end-user data. One reason for that, he says, is
that sales teams working the distribution channels
dont always have an incentive to present the truest
picture on the ground.
If a competitor is gaining market share in a certain
distribution channel, and if the sales team is meeting its quota, there isnt a big incentive to report
that, he says. The situation gets worse particularly
with consumer goods, where third-party logistics
companies handle product deliveries at the retail
level, which has the closest interface with the customer. So companies end up making decisions at
the macro level, not at the distribution channel or
store level, says Reilly.

Thats where customer expertise comes into play,

according to Kahn. One of the factors that makes
[a higher number of offerings possible] is expertise, she says. The more people become experts,
the more they articulate their preferences and
the more they have a consumption vocabulary and
know what the relevant attributes are, the more
variety they will be able to take. She also suggests
arranging [product] assortment in such a way that
consumers just see what it is they want and they
dont have to see all that they dont want. Websites
are really good at that.

From Retailers to Manufacturers, Complexity in Products Begs the Question:

Kahn likens the process of empowering customers
How Much Is Too Much?

Managing Complexity
Wilson points out that complexity can be an organizational drag, consuming resources, diluting focus
and impacting profitability. In that way, it can be a
drag on innovation efforts. But conversely, he notes,
it is important to understand how the current innovation system helps or hinders the issue of complexity. In many situations, the innovation system
itself can be one of the drivers a poor innovation
system can lead to clutter and complexity, he says.
Next, companies must get a grip on what causes
that complexity. Is it a lack of customer knowledge, or poor understanding of the economics of
the situation? asks Wilson. Additionally, he says,
they need to get an accurate picture of the real
effects of complexity.
There are corrective strategies for complexity, he
notes. One of them is to reduce complexity in your
portfolio or in your processes. But reducing your
portfolio is only one strategy, and it may not be the
right strategy for your organization.
Another strategy, says Wilson, is to make your
complexity more approachable for the customer
and make the choices digestible. Indeed, there exist
ways to empower the customer to comfortably deal
with the full range of a companys offerings.
Wharton marketing professor Barbara Kahn says discovering that golden mean of how much is not too
much is the trick. If its too much, they wont deal
with it; if its too little, then they may be able to deal
with it, she says of customers buying patterns.

George Group | Knowledge@Wharton

with how salad bars help patrons navigate a mindboggling range of options. If you thought of all the
different kinds of salads that you could make, and
you presented [customers] all the different options,
people wouldnt be able to deal with that there
would be too much variety, she says. But if you
do it the way [restaurants] do with salad bars, and
divide salads up into attributes ... they can deal with
that variety because they can deal with those different attributes.
A reference point in the form of an expert opinion
could help in such situations, Kahn adds. Even if
you dont take what they recommend, it gives you
a starting point, and you dont have to deal with the
entire set of offerings, she says. You can tweak
that starting point.
Kimberly Watson-Hemphill, vice president at George
Group and co-author of Fast Innovation, recalls
one client that was able to successfully tweak a
market niche for itself, thinking outside the box in
its commoditized world and differentiating its product along a different dimension. The client, a pharmaceutical company that had a me-too product
coming to market, was able to implement a process
to allow customers to get the product covered by
their health insurance policies. They had a process
by which they could frequently get fast insurance
approval, when it would have typically been a timeconsuming, uncertain process, she recalls. So
customers would buy this product instead of their
competitors products, which werent so differentiated on the basis of standard product performance.
But for those that dont find such unique fixes, the
easy answer is not necessarily to throw out SKUs,
warns Wilson. He says a flawed innovation system
driven by internal processes rather than by what
the customer wants could be generating those
SKUs.

Companies that take the quick route to de-proliferate their offerings in an attempt to reduce complexity might end up returning to the same situation
two years later, according to Wilson. That could lead
to another danger, he says, of cutting too shallow
or too often. He warns companies not to underestimate customers memory of portfolio changes.
The last thing you want to do is reduce some of
the complexity, and then two years later tell the customer, We didnt do it properly the last time; were
doing it again. Q

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

Part II: The Impact of Clutter on Time-to-Market

Kimberly Watson-Hemphill, vice president

at Dallas-based George Group Consulting, isnt
going to be surprised if the top management at the
next company she encounters needs insight about
its own product development pipeline. If you ask
companies how many projects they have in process,
many dont even know, she says.
Watson-Hemphill, who co-authored the book Fast
Innovation: Achieving Superior Differentiation,
Speed to Market, and Increased Profitability
(McGraw-Hill, 2005) with Michael George and James
Works, says that it seems all too obvious that companies shouldnt spread their innovation resources
too thin, but in practice it happens frequently.
[Companies] have their top [product or service]
priorities, but then they have a bunch of underlying
things that are just sitting there sucking time away
from the resources, she says. You have people
working on 10 different projects when they have
capacity to work on just one or two.

Companies that invest in innovation

but are late to market fail to capture
the initial gains of market share
where a lot of the profit is made,
says George Groups Stephen Wilson.
Her colleague Stephen Wilson of George Group
sees in such situations not only a disconnect with
internal processes, but also symptoms of being
out of touch with customers and the seeds of mistimed, or late, arrival in the marketplace with new
offerings. If you invest upfront in processes to

George Group | Knowledge@Wharton

understand the customer, you get a better sense of

product or service differentiation, and thats what
is going to secure your gains against commoditization, he says.
Companies that invest in innovation but are late to
market fail to capture the initial gains of market share
where a lot of the profit is made, says Wilson, and
they may be better off not making that investment in
innovation in the first place. Better never than late,
is Wilsons advice to such companies.

Process Innovation and Rightsourcing

Ravi Aron, Wharton professor of operations and
information management, says innovation is not
always about products and services, but actually
needs to be first introduced in processes. Process
innovation makes an organization ready for product
innovation, he says. For new offerings to be successful, Aron notes that companies need to appreciate the significance of two components of their
processes the innovation pivot and the complexity pivot. Process innovation addresses those
two pivots and readies the turf for product innovation, he says.
As an example, Aron cites a large, U.S.-based financial services company that outsourced some of its
operations to India a couple of years ago; the move
helped it ramp up service lines through process
innovation. The company discarded its earlier work
flow patterns that were designed to handle productbased transactions, replacing them with processbased innovation that allowed transactions to be
handled by customer profile.
In other words, customers with multiple requests
across product lines no longer had to make a separate call for every product they were interested in;
the customer support executive dealing with them

would take requests across the range of offerings.

For example, a customer seeking a bank loan from
a financial services company might also want a
credit card or a home mortgage, or to open a savings account or invest in a retirement fund. They
were essentially capable of 360-degree processing
of any transaction that came to them, says Aron
of the revamped customer support staffers. The
company was able to expand its range of offerings
without necessarily increasing staff complements by
a corresponding measure the process innovation
brought scalability in operations.
Aron says that while offshoring has helped many
companies free up process complexity to make way
for product innovation, it is not always the best
option. He points to a recent research paper coauthored by himself and Wharton doctoral students
Lyle Ungar and Annapurna Valluri, which examines
the nature of work complexity and its suitability for
offshoring and outsourcing.
The paper, titled Rightsourcing: The Optimal
Sourcing Mix of Complex, Information-Intensive
Services: Theory and Evidence, is motivated by a
survey conducted by Whartons Fishman-Davidson
Center for Service and Operations Management
and Unisys Corp. The authors demonstrate that a
process called rightsourcing permits firms to optimize operational efficiency and deliver high quality
service to consumers even when the underlying
processes are highly complex.
The paper is clear that not all processes can be outsourced to reduce complexity. It says that processes
that require agents (employees) to understand the
market context and to execute the process efficiently could be sourced in-house. But what can
be offshored, according to the authors, are those
processes that require judgment-intensive work
that is not context-sensitive. They say that complex
processes that can be described in terms of rules of
execution can be automated through a service utility and designed to necessitate human intervention
only for exception-handling.
The researchers show in their paper that partitioning tasks to reduce complexity has worked well at
firms such as Pipal Research, a customized research
services firm based in Chicago with offices in
Mumbai, India. These firms have adopted a model
of partitioning task types and allocating them to
multiple sourcing options and integrating these with
technology to deliver high-quality research solutions, they write.

Speed to Market
Companies that have worked out their scalability
and product positioning issues have to next start
working on speed to market, says Dan Chow, who
leads the Fast Innovation practice at George Group.
There are plenty of ideas that die on the vine
because [companies] could never get them out the
door, he says, adding that companies that take two
to three years to bring new products out are at an
obvious disadvantage to those who can do it in six
months. Speed to market can be a sustainable and
highly differentiated characteristic of the business
model. Speed can put your competition in a constant
state of reaction, creating competitive advantage.
Chow points to the case of Compaq versus Dell, in
which he says the former was actually the leading
innovator and developed PCs that were far superior to others in the market. But Dell, he says, was
able to compete on customization and speed with
its focus on having better knowledge than anybody
else in the marketplace on what customer needs are
and delivering on them faster than others. That combination, Chow says, is critical in an industry where
product life cycles are getting increasingly shorter.
Getting aligned quickly to changing ways of doing
business is equally important for moving products
to the market faster. Wharton professor of legal
studies and business ethics Kevin Werbach cites
Google as one firm that has an inherent advantage
over rivals as more and more products are sold on
the Internet. Google has no legacy, and they basically have one software-based program running on
a global network on tens of hundreds of thousands
of servers, he says. They can iterate much more
quickly than others, as they are directly connected
to their installed base [of customers]. Microsoft, by
contrast, has to get its next version of Windows to
millions and millions of users who have to adopt it
and install it, Werbach says.

Getting Innovation to the Marketplace

Faster
Keep it simple is not one of the simplest lessons
companies learn, as Watson-Hemphill discovered
on a consulting assignment with a U.S. maker of
mobile hydraulic cranes. The company was concerned that although many of its models were
big winners, others were money losers. WatsonHemphill found that the company carried a staggering inventory of raw materials, chiefly steel parts
of varying thicknesses. The engineering experts
ordered what they wanted, she said. If you do

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

that, you optimize the very small at the expense of

the greater good.
Watson-Hemphills prescription was tough to swallow, but she called for a reuse strategy, which
translated into making do with a smaller range of
steel thicknesses for all the crane models and
ensuring that everybody accepted the fewer raw
material choices. Inventory carrying costs fell dramatically, and the company was able to still meet
customer needs with fewer variations in its models.

Taming Complexity in Services: Stay Close to Your Customer (But Not Too Close)

Processes dont necessarily stifle the spirit of innovation, Watson-Hemphill says, adding that in recent
years cost pressures have driven industry away
from research for researchs sake. Its important to
measure the rate at which products in the development pipeline make it to market, because that also
highlights any congestion in the process. She cites
Littles Law, which is explained in Fast Innovation:
The Law of Lead Time, also known as Littles Law
after MIT professor and mathematician John D.C.
Little who first propounded it in 1961, expresses the
average lead time of a process as the number of
things in process divided by the average completion
rate of processes. What Littles Law demonstrates
is that the higher the number of active projects on
hand, the longer it will take for all of them to be
completed. The key lesson, Watson-Hemphill says,
is to slash the number of projects in process by
cherry-picking those with the greatest chances to
succeed. This allows innovation to get out into the
market, versus everything working on multi-year
timeframes and never getting launched.
The warning signs for a doomed product launch are
all too clear in the development stage if you look
for them, says Watson-Hemphill. Case in point: One
client recently told her, We dont have time to do it
right, but we have plenty of time to do it over. Q

George Group | Knowledge@Wharton

Part III: Getting a Grip on the Costs of Complexity

Addressing the negative impacts of

complexity not only releases a large amount of
hidden costs but also helps free up resources,
both human and financial, to accelerate innovation.
But where and perhaps more importantly how
can companies begin unraveling the knot of cost
and complexity?
Dont start by looking at your GAAP accounting
metrics, says Stephen Wilson, engagement director in Dallas-based George Group Consultings
Conquering Complexity practice. Standard
accounting doesnt give you a sense of where
you are creating value in the organization, says
Wilson, co-author of Conquering Complexity in Your
Business (McGraw-Hill, 2004).
According to Wilson and other experts, determining the financial impacts of increased complexity
related to innovation begins with taking a close
look at existing operations to understand the actual
cost incurred and value generated at each step in
the process all the way from idea generation
through product development, manufacturing, marketing and customer support, among other backoffice functions. Such exercises will help in getting
an informed grip on the real value generated by a
companys offerings, and where there are hidden
complexity costs.
Wilson says such a value stream analysis captures the true costs of various process steps that
tend to stay hidden or are inaccurately estimated in
conventional financial analysis. Most companies do
costing studies by classifying the various pieces in
their portfolio of offerings by the specific markets
in which they operate. A garment manufacturer, for
instance, may use a market-based segmentation
method and allocate costs by product groups such
as childrens wear, menswear or womens clothing.

Wilson argues that the process-based segmentation his firm espouses allows for an understanding of how and where products consume costs
and time. That, he says, brings another bonus for
companies working on innovations: It helps you
understand where you have an inherent advantage.
Wilson says it is not uncommon for companies to
earn four-fifths of their economic profit from just
a fifth of their total portfolio. (Economic profit is
defined as the return on invested capital minus the
weighted average cost of capital.)

According to George Groups Stephen

Wilson, Standard accounting ...
doesnt give you a sense of where you
are creating value in the organization.
By employing such advanced analysis tools, companies are also able to accurately identify specific processes that work faster than others, that are inherently superior to competitors and which represent
a vein of innovation opportunity. That could be a
tremendous lever for competitive advantage, he
says. If you have low internal cost [in any process
or processes], you can build upon it. The more you
grow in that area [with new offerings] and the more
your competitors try and match you, they will fail
because they dont have that benefit.
Such analysis will also help management teams
train their sights on processes that are driving up
costs to either bring improvements there, or to make
bigger decisions like whether or not to retain a highcost product or service in their portfolios. I might

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

discover that if I migrate customers from Product A

to Product B, my overall customer service time will
reduce by 30%, says Wilson. Companies achieve
such migration by discontinuing older products and
redirecting customers to new, improved offerings
whose specific processes help with greater profitability compared with those that were pulled out.

The Silo Pattern

Matt Reilly, a senior vice president at George Group,
says the reason the impacts of complexity are not
often captured is that companies have become
siloed, and therefore fail to see the value-stream
view. Such disconnects between product development and other arms of a company are probably
worse in large companies, mainly because they
are also usually more siloed. If you take a look
at a products journey through a companys value
streams, what emerges is that costs and profitability look very, very different if you measure the true
cost to develop, manufacture and deliver, he says.
He notes that companies typically measure cost to
manufacturing based on standard accounting cost.
Reilly visualizes a typical pattern at many companies: The marketing department drives the business plan, and throws it over the wall to R&D to
develop. They then develop a pilot and throw that
over the wall to manufacturing, to manufacture full
scale. Manufacturing then throws that over the wall
to sales, to sell it. Each silo has its own turf, and
tends not to recognize its own impact on the value
stream upstream or downstream. So its not uncommon to hear a marketing executive describe a certain problem as an operations issue or pass the
buck to product development.
This silo pattern showed up in one of Reillys consulting assignments involving an industrial goods
company. Reilly got to the scene as the company
grappled with a new product it felt the market needed but was unable to get its execution right. They
designed the product based on what the customers
end needs were, he says, but after R&D developed
the product, it was thrown over the wall to manufacturing, which struggled to manufacture full scale,
and what emerged was not exactly what the sales
people had sold.
Reilly discovered a tremendous disconnect
between what was developed as an innovation and
what was delivered to the customer. Contrary to
expectations of cornering a large market share, he
says, the company actually captured a very low
percentage, and the reason was they couldnt execute on what they had innovated.

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George Group | Knowledge@Wharton

But fixing those problems presented a $50 million

profit opportunity, says Reilly, who used the value
stream analysis. We segmented the value streams
and helped them to manufacture the new product
in a certain way, and the older products in a certain
way, he says. They were then able to deliver on
the innovation, and the company captured not all,
but most of that opportunity. Q

Humana CEO Mike McCallister: Letting the Consumer Drive Innovation

In the wake of rising medical costs and lowered

reimbursement rates for Medicare, health care companies are finding it increasingly difficult to balance
quality service with strong earnings. At the same
time, the proliferation of products in the industry
has added a layer of complexity that threatens service levels and, in many instances, makes execution
of services more difficult and costly for companies
and consumers alike.
Mike McCallister, CEO of Louisville, Kentucky-based
Humana, one of the United States largest publicly
traded health benefits providers, has grappled with
these issues while leading the company through
the rapid changes the industry has seen during the
past several years. Today, the company is focused
on moving away from the traditional one-size-fitsall health care delivery model adopted by most
employers, to a consumer-centered model one
in which product innovation is driven by consumer
needs. Placing the consumer at the center is not
easy, McCallister admits, because with innovation
comes the potential for additional product and
service complexity; the trick, he says, is delivering
complexity only where consumers are willing to
pay for it.
McCallister spoke with Wharton management
professor Michael Useem and Stephen Wilson,
engagement director in George Group Consultings
Conquering Complexity practice, about his companys take on health care delivery and the challenges
of leading in a changing industry.
Useem: Looking back at how you have grown with
the company since 1974, how you lead people and
how youve led the company, can you offer a couple
of thoughts on what it takes now, in year 2006, to

lead a much more complex, diverse and much larger enterprise than at an earlier point in your career?
McCallister: I might disappoint you if I told you that
Im not sure its any different.

One of the most important

decisions we ever made was to
organize and drive this company
around the simple premise that the
consumer had to be at the heart of
health care, says Humana CEO Mike
McCallister.
Useem: Well thats a perfectly good answer. Could
you elaborate a bit on that?
McCallister: Although there are a number of different tactical things you have to do given the scale,
scope and complexity of what we are today versus what we once were, to me the principles have
always been the same: You find the best people you
can. You get a clear direction for the company. You
delegate the right work to the right people, and then
you get out of their way and let them do it while
holding them all accountable for their performance.
I know thats right out of Management 101, but thats
what you do. Given the complexity of the business
were in today, there are a number of tactical ways
you have to go about doing those simple things I
described, but I think at the core theyre all the same.
Weve had to deal in more of a team environment
than we once did. When Humana was a hospital

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11

company, the business operated as individual, local

units with as many centralized activities as we could
manage. As we tried to integrate health insurance
and hospitals, it became more regional, or at least
metropolitan-wide. When we went into being a pure
employee benefits company in the mid-nineties, our
structure became much more centralized because
insurance is a financial institution more so than
health care. The way we operate and run Humana
has transitioned. Were more data-driven today than
we once were and we have more challenges relative
to applying technology in an effective way. Many of
the agenda items are different, but the core principles
of how you manage the enterprise are the same.
Useem: You have made hundreds, thousands of major
decisions. Could you pick out one of your more difficult decisions and talk about it: What went into it?
How did you reach the decision? What does it take on
your part to make a good and timely decision?
McCallister: Well, Ill pick one that we made not too
long ago. When we decided to set the strategy for
this company after I became CEO in 2000, one of
the most important decisions we ever made was to
organize and drive this company around the simple
premise that the consumer had to be at the heart
of health care. Now theres a lot of talk around that
idea today. Six years ago there wasnt anybody talking about it and there werent many people going
down that path. If you think about health care and
the way it operates and has for a hundred years
very paternalistic, no information its a mother
and father may I kind of environment. To have the
consumer at the core of how its organized seems so
simple and seems so right except when you talk
to health care people, who think its crazy. That decision was a big one and has really guided everything
weve done for the last six years with varying levels
of success.... Whats particularly gratifying is that the
rest of the industry has now decided theyre going
to go down this path, too. We get the benefit of having been at it for a while, and we also take pride in
the fact that we may have helped nudge the industry toward consumers.
Useem: Could you offer a word or two on what
prompted that decision at that time? And, to whom
did you turn for guidance or counsel on that one in
particular?
McCallister: I didnt turn to anyone on the outside.
After thinking about it myself, I engaged a handful
of Humanas key people, and together we tried to
figure out where we were going to take the company, how we were going to fix it and change it. Those

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George Group | Knowledge@Wharton

key people had an incredible mix of knowledge

from both in and outside the industry, and quite
frankly there wasnt much going on outside that
would have led us down the consumer path.
We were trying to answer a very, very big question: What would it take to rationalize health care
and the cost of health care in the US? We started
putting down everything thats been tried, everything thats failed, everything thats worked there
havent been too many things that have worked.
When we started listing the history of it, all the
various components, all the various approaches
that people have tried to apply over many, many
years, it quickly became clear that the one thing no
one had ever tried was to get the consumer at the
heart of this. But it didnt start with, We think the
consumers great. Lets a make a case for it. It was
the other way around. We looked at a blank sheet
of paper and asked ourselves, if were going to try
to do something about the cost of health care and
health insurance, how do we do it?
Useem: Was this a deliberation on the inside that
took place over six months? A year? How much of
your own time did you focus on this before you
finally said this is a go?
McCallister: At the hundred-thousand-foot level it
didnt take too long to agree the consumer was the
way to go. Then we started bringing it down to fifty
thousand feet and said, All right, if the consumers
going to be the core of what we think, then what are
the next steps we take to make that happen? That
took longer, probably more like a year in the making. Some great things came out of all those conversations. Its not on our strategy page, but as soon
as we decided that the consumer was where we
wanted to be, it was clear we were going to have
to be an innovator as well, because it was going to
take some innovations in the industry to bring the
consumer to the center. Innovation is a core component of making that happen.
Useem: In focusing on the consumer, you in a sense
opened up a Pandoras box. Every consumer has a
slightly different set of needs, and so inherently the
universe becomes more complex, more diverse.
How have you coped, managed, led when youve
invited greater complexity into the way you do just
about everything you do?
McCallister: First of all, one of the faults in all of
health care as far as Im concerned is an attitude
that everyones the same. A lot of the solutions
around health insurance and health care tend to
be one size fits all. I would stipulate that the con-

sumer world is very complex, that people need and

want different things. For an employer or any buyer
of insurance to pretend that they know what all their
people need is outrageous. I start with the underlying principle that consumers are different. They all
need different things and they want different things,
and its interesting that the rest of the economy
responds to that every single day. Consumers
drive everything except in health care, where
people try to do top-down to these folks. Ill stipulate that its complex, stipulate that maybe its more
difficult to meet a consumer where they are, but
thats exactly what has to be done if youre going to
engage consumers. If you dont get down to their
individual level and meet their needs, find what
theyre going to respond to, the chance that collectively theyre going to change anything is zero.
Useem: Has this affected how you run your office or
the way you work with your top team?
McCallister: Its made the companys head spin,
because you have people in two different camps.
You have people in the old camp of the business,
those who believe we have to do better at what
weve been doing. Then you have those who are
ready to go down a different path and try to find a
different way. The friction between the two can be
significant, and generates another level of complexity in what was already a complex business. The
real trick there is to separate the good complexity
from the bad complexity: If youre going to respond
to consumers and try to meet them where they are,
it will generate some complexity, but try to stay
away from whats not important and what consumers wont pay for.
Useem: Are there other companies, or even other
industries, that provided some thinking through,
some guidance or some models for what youre
doing now?
McCallister: There are probably some components
from a number of places. Ill give you one: Dell
computer has done a nice job of managing complexity and delivering complexity people will pay
for. Although they provide a lot of selections, theres
less complexity there than most people would
think. There are any number of consumer products
and other consumer brands where they have done
things you never would have dreamed of on the
backs of consumers. Starbucks is a great example.
Who would have thought you could have sold consumers that kind of coffee? They responded to some
need that was yet unidentified.

I can probably go on and on, but I looked at technology from the standpoint of its importance. Even
in 2000 it was clear that people were going to do
significant transactional work over the Internet, that
people were going to seek out information on the
Internet and they were going to use the Internet for
comparisons and for better pricing on products. That
was a big piece of this. Just imagine the information flow that would be necessary in health care
to get people engaged and empowered. Its crucial
that the Internet be the core process for that. All
of the Internet companies that were responding to
consumers were decent models to look at, certainly
from an information-flow perspective.

The real trick is to separate

the good complexity from the bad
complexity, says McCallister.
Useem: If someone from another industry or maybe
another company in the same terrain came to you
and said, Mike youve been through it. Are there a
couple pitfalls to be avoided? are there a couple
of lessons that you would pass on to them?
McCallister: One that comes to mind, quickly, would
be that in an era of technology expansion and explosion like we have today, I think any business in any
industry really has to carefully achieve a level of
standardization things necessary to fully maximize
the technology uptake and productivity gains that are
potentially out there. That was pretty natural in our
business, because we have such high transactional
work. I think youve got to quickly connect the process orientation with the application of technology.
Useem: Back on the pitfall side anything that you
would have done differently or would tell someone,
Watch out for this going forward?
McCallister: If you try to make any significant changes to your business or in your industry, you better
get a backbone, because critics will come out of the
woodwork. Be ready to withstand a fair amount of
criticism from those who believe differently.
Useem: And youre speaking both in the industry at
large and then in your own ranks, of course.
McCallister: Absolutely.
Useem: With complexity comes a required focus on
that diverse terrain that takes up more time, more

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13

energy. How has this increasing focus on the consumer and all the complexity that it has brought
affected your ability to be innovative and still
come up with great solutions to the problems that
consumers face?
McCallister: Two big issues to me. We organized
a separate innovation group because I believed it
was going to take that, given the fact that we were
an old company that had been around a long time.
We were going to require some separate people
to be innovative because it wasnt going to come
naturally elsewhere. That generates another couple
of issues. One is that the innovative types arent
always caught up in whats actually doable, so a
natural friction ensues. Its not just a question of
whats actually do-able from the standpoint of building out and delivering something, but what the market will eat, so to speak, as well as the execution of
some of the innovative things that can come up. Its
hard in a company thats fighting over resources to
fund innovation, especially if it doesnt have shortterm payback, because the people who are trying
to make the trains run on time every day get a little
frustrated with that burning of resources. But you
have to get committed to some level of burn to keep
an innovative engine going.
Useem: I wanted to give my colleague here, Stephen
Wilson, an opportunity to ask some questions.
Wilson: Mike, one of the impacts of product and
service complexity is that it can impair execution
service levels. So as you go towards consumerdriven health care, what are the implications for the
back office for execution, and how would you rate
the overall industry in that regard?
McCallister: I think we in the industry allow our
complexity to be the wrong kind at the wrong
place. We allow our customer-employers to drive
complexity as opposed to letting consumers drive
it, which is the right way. Our industry has poorly
controlled bad complexity relative to the historic
sales model to employers. I think were early in
figuring out exactly what complexity were going
to be able to manage and put in front of consumers directly ... well have to see how that plays out.
I think the complexity that we manage, tolerate and
make good at the consumer level has big potential.
Ongoing complexity in the back office from an old
model is absolutely non-value-added.
Useem: Mike, let me quickly add a question onto
that one. Could you just identify an example or two
that shows the difference between a consumer-

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George Group | Knowledge@Wharton

driven need as opposed to an employer-driven

need? How have you worked with that difference?
McCallister: Employers are trying to satisfy the
health insurance needs of lots of people in one fell
swoop. That causes them to go with a lowest common denominator concept. In other words, what
would it take to satisfy as many of these people as
I can possibly satisfy? Its just that simple, and the
driving force there will be, What will it take for
me as an employer to have everybody feel pretty
good about working here? which is important,
because no one wants to lose people over benefits.
On the other hand, if you go to a consumer-driven
model, youre letting the individual consumer
decide what their blend of risk tolerance is, what
their economics are, the type of things they want
from health insurance, how important different
levels of benefits are for them in the context of
their overall family environment. I could have two
employees standing next to each other: One just
won the lottery, and the other one is barely making
ends meet. As far as their relationship to me goes,
theyre doing the same job and making the same
money. Its as simple as letting the individual decide
the coverage, [based on] short-term versus longterm economics the risk tolerance they have, versus an employer trying to do it on a broad basis for
a lot of people.
Wilson: What is the role of management in this
industry, particularly in driving innovation while
keeping complexity at bay?
McCallister: You have startup companies that are
totally innovation driven. Thats pretty straightforward and pretty simple. Weve had companies in
our space that just stayed consistent with their old
approaches, and thats pretty simple. The trick is
when you start putting them together and managing all of the organizational implications, as well as
having a reasonable focus: What are you all about
as a company, and how are you going to approach
the market? Weve been through all those issues
and difficulties and we continue to get better at it....
I think that managements job is to balance all those
horses, keep the organization pointed in the right
direction. Senior management has to be the leader
relative to driving innovation, because they have to
make the organization feel comfortable with it.
One of the things weve tried to develop around
here is a learning organization. When we first
started that process, I got reactions like, I dont
know what youre talking about a learning orga-

nization? And so weve worked on that over the

last few years and developed it. Weve come a long
way. I think that goes hand-in-hand with innovation. Innovation requires people to learn different
things it requires a culture built around the idea
that learning is okay. I think weve come a long way
there.
Useem: Looking ahead to the next couple of years,
what do you see as one of the bigger challenges
coming along for you, personally, either inside the
company or as your own market changes?
McCallister: Well, I have a big piece of work in front
of me as we speak, and its specific to the Medicare
program. We are a major player in the expansion of
the Medicare program, so we have millions of new
customers. Inside a highly politically charged business we have a big job to execute on the concept of
consumer engagement, because the Medicare program essentially operates as a retail consumer business on a scale weve never seen in our industry. We
have a wonderful opportunity in front of us to take
much of what weve been trying to execute relative
to consumer engagement, information, the use of
technology, etc., and apply it to a very large, new
business. Thats very exciting. We hope to take these
ideas much further down the path with this population over the next couple of years. Q

Smart Growth: Innovating to Meet the Needs of the Market without Feeding the Beast of Complexity

15

Special Report

Smart Growth: Innovating to Meet

the Needs of the Market without
Feeding the Beast of Complexity
Fo r f u r t h e r i n f o r m ation, please visit:

www.georgegroup.com

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